Introduction
Mao Tse-tung once commented that “the only real defense is an active defense.” In other words, when confronted with aggressive behavior, a party should respond by counterattacking and taking the offensive. By going on the offensive, a person can destroy the aggressor’s ability to attack.
Oddly enough, naval war adages can be made applicable to bankruptcy cases. Often, faced with foreclosure or entry of an adverse judgment, a borrower will commence a bankruptcy case in order to obtain the protections of the automatic stay under Bankruptcy Code section 362(a). When faced with a bankruptcy filing, it is natural for a lender to respond by treading lightly and avoiding any action that might be deemed a violation of the automatic stay. On the other hand, by the time a borrower files for bankruptcy protection, the lender may have spent months or years and often tens of thousands of dollars or more to pursue claims that will eventually succeed. It is particularly frustrating to have to stand down just when the end appears in sight. Given that many of these borrowers file in bad faith and with no intent to actually comply with the Bankruptcy Code or Bankruptcy Rules, the bankruptcy filing only serves to delay the inevitable, often at yet further significant cost and expense that will never be recovered.
Fortunately, Congress has provided secured creditors with tools to combat the bad faith filer and take a more proactive role in bringing the debacle to an end. As detailed below, some of these options can be used to obtain a quick dismissal to the bankruptcy case or relief from the stay. However, if an expedited dismissal is not possible, then secured creditors can take certain steps to proceed through the bankruptcy case as promptly as possible.
Tools to Utilize to Obtain Quick Dismissal or Relief From Automatic Stay
It happens more frequently than one would expect – an individual commences a Chapter 7, 11, or 13 case to prevent a foreclosure but then fails to file all the documents necessary to continue the case. The case is dismissed within thirty days, and the lender schedules another foreclosure sale. However, on the eve of foreclosure, the debtor files a second petition. This abusive behavior can continue over and over without any repercussions. If a secured lender fails to be proactive, borrowers can thwart foreclosure sales for years. Tools for countering this behavior are set forth below.
Two Filings in a One-Year Period
When a debtor files a second case after dismissal of the first case, there is a presumption that the second bankruptcy case was filed in bad faith, and the automatic stay will terminate, “with respect to the debtor,” 30 days after the commencement of the second filing. In order to continue the automatic stay beyond those 30 days, a debtor must set forth “clear and convincing evidence” that the second case was filed in “good faith.” In determining good faith, a debtor must establish a substantial change in its financial or personal affairs. This is a difficult standard for any debtor to meet, let alone the debtor who is filing bankruptcy solely to stop a scheduled foreclosure sale.
The problem is that often secured lenders will not receive adequate notice of the second bankruptcy filing. Further, published opinions and personal experience teach that bankruptcy judges will often continue the automatic stay if there is no objection to the debtor’s motion, notwithstanding the fact that the debtor has not demonstrated that his or her second case was filed in good faith. To ensure that one receives timely notice of a second filing, it is advisable for secured lenders to create a database of debtors who have the potential to be serial filers – namely, those debtors that filed for bankruptcy protection shortly before a foreclosure sale and had their cases dismissed for failing to file necessary documents with the bankruptcy court. Secured creditors could then run searches on these individuals through the bankruptcy court’s online PACER database on a weekly basis to determine if these individuals filed a second bankruptcy case.
Over Two Filings in a One-Year Period
If a debtor files a third case after the prior two were dismissed (except for dismissals for abuse under Bankruptcy Code section 707(b)), the automatic stay does not go into effect at all due to Bankruptcy Code section 362(c)(4)(A)(i). Therefore, in such a situation, a secured creditor does not have to seek relief from the automatic stay to continue with the foreclosure sale. However, to be safe, a lender can request a comfort order stating that no stay is in effect, which is to be provided by the Bankruptcy Court “promptly.”
Multiple Filings by Different Debtors Involving the Same Property
After the borrower’s first and second cases are dismissed, a secured lender will usually schedule another foreclosure sale. A bad faith debtor will not just file bankruptcy again, but will rather transfer the property to a third party shortly before the rescheduled foreclosure sale. The transferee will then file a bankruptcy case on the eve of foreclosure.
In such a circumstance, a secured lender should seek in rem relief from the automatic stay under Bankruptcy Code section 362(d)(4), which affects the property, and not the individual debtor. This section provides that the relief from stay order “will be binding in any other case under this title purporting to affect such real property filed not later than 2 years after the date of the entry of such order by the court. . . .” Therefore, if a secured lender obtains an order granting in rem relief from the automatic stay, the property is not covered by any automatic stay for a two-year period.
To prevail on a motion for relief from the automatic stay under § 362(d)(4), a movant must establish that three elements are present: (1) the debtor’s bankruptcy filing was part of a scheme, (2) the object of the scheme was to delay, hinder, or defraud creditors; and (3) the scheme must involve either (a) the transfer of some interest in the real property without the secured creditor’s consent or court approval or (b) multiple bankruptcy filings affecting the real property.
Often, the key to obtaining in rem relief is to file the motion for relief before the debtor’s case is dismissed. Bankruptcy courts will not hesitate to dismiss cases quickly if the debtor only filed a two-page voluntary petition to initiate a case. Hence, it is advisable to have an in rem motion, along with supporting pleadings and evidence, prepared before the third or fourth case involving the debtor is commenced. That way, a secured lender can act immediately when it learns of the filing of the bankruptcy case that affects the property.
Procedures to Use Within a Bankruptcy Case to Expedite Resolution of Claim
Unfortunately, there are circumstances when bad faith bankruptcy filings are not dismissed and creditors cannot promptly obtain relief from the stay. While it is certainly frustrating to be stuck in a bankruptcy case that never should have been filed in the first place, there are certain actions that a creditor can take to expedite the determination of its claim against a debtor/borrower.
Immediately File Claim and Complaint or Motion for Allowance
Secured creditors should file a proof of claim, with all supporting documentation, as soon as possible after the initiation of a bankruptcy case. A properly filed proof of claim is deemed allowed. However, the immediate filing of a proof of claim does not mean that the court will consider the claim, and any objections thereto, on a timely basis. Hence, in theory, a bad faith debtor could string out the claims objection process indefinitely. This delay in determining the validity of a claim is often connected to a bad faith debtor that was about to be defeated in prepetition litigation. If a debtor is about to lose in litigation, he or she may initiate a bankruptcy case to stay the litigation and obtain a different forum. Even a good faith debtor would not have any motivation to speedily resolve the adjudication of a secured claim.
In order to expedite the determination of both the secured status and validity of the secured creditor’s filed claim, the secured creditor may commence an adversary proceeding under Bankruptcy Rule 7001(2), which defines an adversary proceeding as a “proceeding to determine the validity, priority, or extent of a lien or other interest in property.” The benefit of filing a complaint is that the secured creditor will control the pace of the proceedings as plaintiff. At the initial status conference, secured creditors can request relatively expedited deadlines for discovery and pre-trial motions. As a result, the secured creditor will not be at the whim of the debtor and his/her timetable and can obtain the adjudication of its claim on an accelerated basis.
Alternatively, a secured creditor could file a motion under Bankruptcy Code section 506 to determine the secured status of its claim. Such motions are allowed under Bankruptcy Rule 3012, which states that “[t]he court may determine the value of a claim secured by a lien on property in which the estate has an interest on motion of any party in interest.” Assuming that the secured creditor properly perfected its security interest and filed all relevant documents with the court, it is possible for a bankruptcy court to make a determination that the secured creditor’s claim is allowed and secured by the debtor’s property shortly after the commencement of the bankruptcy case.
There are many significant effects from the allowance of a secured claim. Most importantly, a debtor cannot stall and prolong a bankruptcy case due to the filing of some vague claim objection (such as an objection stating that the secured creditor’s claim should be disallowed because it is not the proper holder of a note). Further, once a secured creditor possesses an allowed claim, it has many options that it can use to be on the offense. If the secured creditor is over-collateralized, it can file a motion requesting adequate protection payments from the debtor, which would also include attorneys’ fees and costs of enforcement. If the debtor is unable to make such payments on a timely basis, a secured creditor can file a motion for relief from the automatic stay to continue with foreclosure efforts. Alternatively, if the collateral is worth less than the secured creditor’s claim, that creditor could seek relief from the stay on the grounds that the debtor does not possess equity in the property and the property is not necessary for an effective reorganization.
Assert Claims Against Non-Debtor Guarantors
While the automatic stay prevents creditors from bringing claims against a debtor, no such stay extends to non-debtor guarantors of the liability. In order to obtain leverage against a debtor that has not demonstrated any incentive to move his or her case forward, a creditor should consider bringing actions against guarantors or co-obligors of debts. Often, the close relationship between the debtor and guarantor will cause the debtor to confront the secured creditor’s claim sooner that it would do so otherwise.
If Plan Is Confirmed, Closely Monitor the Debtor
Notwithstanding these options, there are times that a creditor’s claim will still be disputed after confirmation of a Chapter 11 or Chapter 13 plan. In such a circumstance, creditors should closely monitor the debtor’s progress under the terms of a confirmed plan, because a debtor’s failure to comply with the terms of a plan can work to the benefit of a creditor.
For instance, in Chapter 11 cases, Bankruptcy Code section 1112(b) states that a case shall be converted or dismissed “for cause.” Section 1112(b)(4) lists several examples of “cause,” including (i) the failure to comply with an order of the court or (ii) the material default by the debtor with respect to a confirmed plan. Similarly, with respect to confirmed Chapter 13 plans, Bankruptcy Code section 1307(c) allows a court to convert or dismiss a case if the debtor commits a material default under the confirmed plan. Courts generally find that the failure to make a payment under a confirmed plan constitutes a “material default.” Therefore, in Chapter 11, a court must convert or dismiss a case where a debtor fails to make a payment under the plan unless the court finds unusual circumstances dictating that conversion or dismissal is not in the best interest of creditors.
If a party has reason to believe that a debtor is not complying with the terms of a confirmed plan, but cannot obtain proof of such a default, it can apply to the court for authority to conduct a Bankruptcy Rule 2004 examination of the debtor. Rule 2004 examinations can involve both the production of documents and a deposition of the debtor. If a secured creditor focuses its inquiries on a particular suspected default, it will likely be in a good position to determine whether cause exists for conversion or dismissal of a case.
Conclusion
With respect to the procedures discussed above, it is important to note that practices vary greatly among judges. For example, some judges are more likely to issue a section 362(c)(4)(A)(ii) comfort order promptly than others. Additionally, some judges will allow a secured creditor’s motion to be heard on shortened time without having to file an application for an order shortening time. It is important to check the website of each judge and review their “chamber rules.”
In sum, even though individual debtors continue to abuse the bankruptcy process, secured lenders have remedies that can be particularly effective when used in an aggressive and uncompromising manner.
Published November 19, 2014.
